Managerial

Accounting
Carlo Ian A. Manalansan, MSBA
 ILOCOS SUR
POLYTECHNIC STATE
Tagudin Campus
COLLEGE

MODULE 2

Module 2: Managerial Accounting and Cost Concepts

- For an in-depth discussion of the module, refer to “Chapter 2: Managerial
Accounting and Cost Concepts” of the given textbook, Managerial
Accounting by Garrison, et. al

LEARNING OBJECTIVES
In this chapter you will learn to:
• Understand cost classifications used for assigning costs to cost objects:
direct costs and indirect costs.
• Identify and give examples of each of the three basic manufacturing cost
categories.
• Understand cost classifications used to prepare financial statements:
product costs and period costs.
• Understand cost classifications used to predict cost behavior: variable
costs, fixed costs, and mixed costs.
• Understand cost classifications used in making decisions: differential
costs, sunk costs, and opportunity costs.
• Prepare income statements for a merchandising company using the
traditional and contribution formats.

Needs of Management
• Financial accounting is concerned with reporting financial information to
external parties, such as stockholders, creditors, and regulators.
• Managerial accounting is concerned with providing information to managers
within an organization so that they can formulate plans, control operations,
and make decisions.

Purposes of Cost Classification

1. Assigning costs to cost objects
2. Accounting for costs in manufacturing companies
3. Preparing financial statements
4. Predicting cost behavior in response to changes in activity
5. Making decisions

Learning Objective 1
Understand cost classifications used for assigning costs to cost objects: direct costs
and indirect costs.

Assigning Costs to Cost Objects

• Direct costs
– Costs that can be easily and conveniently traced to a unit of product or
other cost object.
– Examples: direct material and direct labor
• Indirect costs
– Costs that cannot be easily and conveniently traced to a unit of
product or other cost object.
– Example: manufacturing overhead
• Common costs

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 2 Instructor: Carlo Ian A. Manalansan
 ILOCOS SUR
POLYTECHNIC STATE
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MODULE 2
– Indirect costs incurred to support a number of cost objects. These
costs cannot be traced to any individual cost object.

Learning Objective 2
Identify and give examples of each of the three basic manufacturing cost categories.

Classifications of Manufacturing Costs

• Direct Materials
• Direct Labor
• Manufacturing Overhead

Direct Materials
• Direct materials are raw materials that become an integral part of the product
and that can be conveniently traced directly to it.
• Example: A radio installed in an automobile

Direct Labor
• Direct labor costs are those labor costs that can be easily traced to individual
units of product.
• Example: Wages paid to automobile assembly workers

Manufacturing Overhead
• Manufacturing overhead includes all manufacturing costs except direct
material and direct labor. These costs cannot be readily traced to finished
products.
– Includes indirect materials that cannot be easily or conveniently
traced to specific units of product.
– Includes indirect labor costs that cannot be easily or conveniently
traced to specific units of product.
• Examples of manufacturing overhead:
– Depreciation of manufacturing equipment
– Utility costs
– Property taxes
– Insurance premiums incurred to operate a manufacturing facility
• Only those indirect costs associated with operating the factory are included in
manufacturing overhead.

Prime Costs and Conversion Costs

Manufacturing costs are often classified as follows:
• Prime Cost
– Direct Material
– Direct Labor
• Conversion Cost
– Direct Labor
– Manufacturing Overhead

Nonmanufacturing Costs
• Selling Costs

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 3 Instructor: Carlo Ian A. Manalansan
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POLYTECHNIC STATE
Tagudin Campus
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MODULE 2
– Costs necessary to secure the order and deliver the product. Selling
costs can be either direct or indirect costs.
• Administrative Costs
– All executive, organizational, and clerical costs. Administrative costs
can be either direct or indirect costs.

Learning Objective 3
Understand cost classifications used to prepare financial statements: product costs
and period costs.

Product Costs
• Product costs includes all the costs that are involved in acquiring or making a
product.
• Product costs “attach” to a unit of product as it is purchased or manufactured
and they stay attached to each unit of product as long as it remains in
inventory awaiting sale.

Manufacturing Product Costs

For manufacturing companies, product costs include:
• Raw materials: includes any materials that go into the final product.
• Work in process: consists of units of product that are only partially complete
and will require further work before they are ready for sale to the customer.
• Finished goods costs: consists of completed units of product that have not
yet been sold to customers.

Transfer of Product Costs

• When direct materials are used in production, their costs are transferred from
Raw Materials to Work in Process.
• Direct labor and manufacturing overhead costs are added to Work in Process
to convert direct materials into finished goods.
• Once units of product are completed, their costs are transferred from Work in
Process to Finished Goods.
• When a manufacturer sells its finished goods to customers, the costs are
transferred from Finished Goods to Cost of Goods Sold.

Cost Classifications for Preparing Financial Statements

Product costs include direct materials, direct labor, and manufacturing
overhead.

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 4 Instructor: Carlo Ian A. Manalansan
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POLYTECHNIC STATE
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MODULE 2
Period costs include all selling costs and administrative costs.

Quick Check 1
Which of the following costs would be considered a period rather than a
product cost in a manufacturing company?
A. Manufacturing equipment depreciation.
B. Property taxes on corporate headquarters.
C. Direct materials costs.
D. Electrical costs to light the production facility.
E. Sales commissions.

Learning Objective 4
Understand cost classifications used to predict cost behavior: variable costs, fixed
costs, and mixed costs.

Cost Classifications for Predicting Cost Behavior

• Cost behavior refers to how a cost will react to changes in the level of
activity.
• The most common classifications are:
– Variable costs.
– Fixed costs.
– Mixed costs.

Variable Cost
• A cost that varies, in total, in direct proportion to changes in the level of
activity.
• A variable cost per unit is constant.

An Activity Base (Cost Driver)

• A measure of what causes the incurrence of a variable cost
– Units produced
– Machine hours
– Miles driven
– Labor hours

Fixed Cost
• A cost that remains constant, in total, regardless of changes in the level of
the activity.

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 5 Instructor: Carlo Ian A. Manalansan
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POLYTECHNIC STATE
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MODULE 2
• If expressed on a per unit basis, the average fixed cost per unit varies
inversely with changes in activity.

Types of Fixed Costs

• Committed
– Long-term, cannot be significantly reduced in the short term
• Discretionary
– May be altered in the short-term by current managerial decisions

The Linearity Assumption and the Relevant Range

A straight line closely approximates a curvilinear variable cost line within the
relevant range.

Fixed Costs and the Relevant Range

• The relevant range of activity pertains to fixed cost as well as variable
costs. For example, assume office space is available at a rental rate of
P30,000 per year in increments of 1,000 square feet.
• Fixed costs would increase in a step fashion at a rate of P30,000 for each
additional 1,000 square feet.

Relevant Range: Graphic

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 6 Instructor: Carlo Ian A. Manalansan
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POLYTECHNIC STATE
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MODULE 2
The relevant range of activity for a fixed cost is the range of activity over
which the graph of the cost is flat.

Comparison of Cost Classifications for Predicting Cost Behavior

Behavior of Cost (within the relevant range)

Quick Check 2
Which of the following costs would be variable with respect to the number of
ice cream cones sold at a Baskin & Robbins? (There may be more than one
correct answer.)
A. The cost of lighting the store.
B. The wages of the store manager.
C. The cost of ice cream.
D. The cost of napkins for customers.

Mixed Costs
A mixed cost contains both variable and fixed elements. Consider the
example of utility cost.

The total mixed cost line can be expressed as an equation: Y = a + bX

Where:
Y = The total mixed cost.
a = The total fixed cost (the vertical intercept of the line).

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 7 Instructor: Carlo Ian A. Manalansan
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MODULE 2
b = The variable cost per unit of activity (the slope of the line).
X = The level of activity.

Example:
If your fixed monthly utility charge is $40, your variable cost is $0.03 per kilowatt
hour, and your monthly activity level is 2,000 kilowatt hours, what is the amount
of your utility bill?
Y = a + bX
Y = $40 + ($0.03 × 2,000)
Y = $100

Learning Objective 5
Understand cost classifications used in making decisions: differential costs, sunk
costs, and opportunity costs.

Cost Classifications for Decision Making

• Decisions involve choosing between alternatives. The goal of making
decisions is to identify those costs that are either relevant or irrelevant to the
decision.
• To make decisions, it is essential to have a grasp on three concepts:
differential costs, sunk costs, and opportunity costs.

Differential Costs
• Differential costs (or incremental costs) are the difference in cost between
any two alternatives.
• A difference in revenue between two alternatives is called differential
revenue.
• Both are always relevant to decisions.
• Differential costs can be either fixed or variable.

Sunk Costs
• Sunk costs have already been incurred and cannot be changed now or in the
future.
• These costs should be ignored when making decisions.

Opportunity Cost
• The potential benefit that is given up when one alternative is selected over
another.
• These costs are not usually found in accounting records but must be explicitly
considered in every decision.
• For students: What is the opportunity cost you incur by attending class?

Quick Check 3
Suppose you are trying to decide whether to drive or take the bus to Baguio
to attend a concert. You have ample cash to do either, but you don’t want to
waste money needlessly. Is the cost of the tbus ticket relevant in this
decision? In other words, should the cost of the train ticket affect the

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 8 Instructor: Carlo Ian A. Manalansan
 ILOCOS SUR
POLYTECHNIC STATE
Tagudin Campus
COLLEGE

MODULE 2
decision of whether you drive or take the bus to Baguio?
A. Yes, the cost of the train ticket is relevant.
B. No, the cost of the train ticket is not relevant.

Quick Check 4
Suppose you are trying to decide whether to drive or take the bus to Baguio to
attend a concert. You have ample cash to do either, but you don’t want to waste
money needlessly. Is the annual cost of licensing your car relevant in this
decision?
A. Yes, the licensing cost is relevant.
B. No, the licensing cost is not relevant.

Quick Check 5
Suppose that your car could be sold now for
$5,000. Is this a sunk cost?
A. Yes, it is a sunk cost.
B. No, it is not a sunk cost.

Learning Objective 6
Prepare income statements for a merchandising company using the traditional and
contribution formats.

The Traditional and Contribution Formats

Traditional Format à Used primarily for external reporting.

Contribution Format à Used primarily by management.

Uses of the Contribution Format

The contribution income statement format is used as an internal planning and
decision-making tool. We will use this approach for:
1. Cost-volume-profit analysis (Chapter 5).
2. Segmented reporting of profit data (Chapter 6).
3. Budgeting (Chapter 8).
4. Special decisions such as pricing and make-or- buy analysis (Chapter 12).

Summary

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 9 Instructor: Carlo Ian A. Manalansan
 ILOCOS SUR
POLYTECHNIC STATE
Tagudin Campus
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MODULE 2
In this chapter, we have discussed ways in which managers classify costs. How the
costs will be used—for assigning costs to cost objects, preparing external reports,
predicting cost behavior, or decision making—will dictate how the costs are
classified.

For purposes of assigning costs to cost objects such as products or departments,

costs are classified as direct or indirect. Direct costs can be conveniently traced to
cost objects. Indirect costs cannot be conveniently traced to cost objects

For external reporting purposes, costs are classified as either product costs or period
costs. Product costs are assigned to inventories and are considered assets until the
products are sold. At the point of sale, product costs become cost of goods sold on
the income statement. In contrast, period costs are taken directly to the income
statement as expenses in the period in which they are incurred

For purposes of predicting how costs will react to changes in activity, costs are
classified into three categories—variable, fixed, and mixed. Variable costs, in total,
are strictly proportional to activity. The variable cost per unit is constant. Fixed costs,
in total, remain the same as the activity level changes within the relevant range. The
average fixed cost per unit decreases as the activity level increases. Mixed costs
consist of variable and fixed elements and can be expressed in equation form as Y =
a + bX, where Y is the total mixed cost, a is the total fixed cost, b is the variable cost
per unit of activity, and X is the activity level.

For purposes of making decisions, the concepts of differential cost and revenue,
sunk cost, and opportunity cost are vitally important. Differential costs and revenues
are the costs and revenues that differ between alternatives. Sunk cost is a cost that
occurred in the past and cannot be altered. Opportunity cost is the benefit that is
forgone when one alternative is selected over another. Differential costs and
opportunity costs should be carefully considered in decisions. Sunk costs are always
irrelevant in decisions and should be ignored.

Different cost classifications for different purposes is the unifying theme of this
chapter and it can be highlighted by contrasting traditional and contribution format
income statements. The traditional income statement format is used primarily for
external reporting purposes. It organizes costs using product and period cost
classifications. The contribution format income statement aids decision making
because it organizes costs using variable and fixed cost classifications.

Answers to Quick Check:

Quick Check 1: B, E
Quick Check 2: C, D
Quick Check 3: A
Quick Check 4: B
Quick Check 5: B

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 1 Instructor: Carlo Ian A. Manalansan
0
 ILOCOS SUR
POLYTECHNIC STATE
Tagudin Campus
COLLEGE

MODULE 2

INTENDED LEARNING ACTIVITY

Review Questions/Applications
1. What are the three major types of product costs in a manufacturing company?
Give an example for each.
2. Define and give example of the following:
a. direct materials
b. indirect materials
c. direct labor
d. indirect labor
e. manufacturing overhead.
3. Explain the difference between a product cost and a period cost. Concretize
your answer by providing specific examples.
4. Distinguish between the following and provide examples or scenarios for
each:
a. a variable cost
b. a fixed cost
c. a mixed cost.
5. What effect does an increase in the activity level have on—
a. Unit fixed costs?
b. Unit variable costs?
c. Total fixed costs?
d. Total variable costs?
6. What is meant by an activity base when dealing with variable costs? Give
several examples of activity bases.
7. What is the difference between a traditional format income statement and a
contribution format income statement?
8. What is the contribution margin?
9. Define the following terms: differential cost, sunk cost, and opportunity cost.
10. Only variable costs can be differential costs. Do you agree? Explain.

ACTIVITY/ASSESSMENT
1. Mangangahoy Company manufactures furniture, including tables. Selected
costs are given below:
a. The tables are made of wood that costs P200 per table.
b. The tables are assembled by workers, at a wage cost of P40 per table.
c. Workers assembling the tables are supervised by a factory supervisor
who is paid P38,000 per year.
d. Electrical costs are P2 per machine-hour. Four machine-hours are
required to produce a table.
e. The depreciation on the machines used to make the tables totals
P10,000 per year. The machines have no resale value and do not wear
out through use.
f. The salary of the owner of the company is P100,000 per year.
g. The company spends P250,000 per year to advertise its products.
h. Salespersons are paid a commission of P30 for each table sold.
i. Instead of producing the tables, the company could rent its factory

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 1 Instructor: Carlo Ian A. Manalansan
1
 ILOCOS SUR
POLYTECHNIC STATE
Tagudin Campus
COLLEGE

MODULE 2
space for P50,000 per year.

Required: Classify these costs according to the various cost terms used in
the module. Carefully study the classification of each cost.

(If you don’t understand why a particular cost is classified the way it is, reread
the section of the book/module discussing the particular cost term. The terms
variable cost and fixed cost refer to how costs behave with respect to the
number of tables produced in a year.)

2. The Tagabuo ng PC assembles custom computers from components supplied

by various manufacturers. The company is very small and its assembly shop
and retail sales store are housed in a single facility in a Tagudin, Ilocos Sur.
Listed below are some of the costs that are incurred at the company.

Required:
For each cost of Tagabuo ng PC, indicate whether it would be classified as
direct materials, direct labor, manufacturing overhead, selling, or an
administrative cost. Explain your answer for each.
a. Rent on the facility in Tagudin, Ilocos Sur.
b. The cost of advertising in the PCMag Philippines.
c. The wages of employees who assemble computers from each
components.
d. Sales commissions paid to the company’s own salespeople.
e. The salary of the assembly shop’s supervisor.
f. The salary of the company’s accountant.
g. Depreciation on equipment used inspect laptops before release to
Tagabuo ng PC customers.
h. The cost of a hard drive (HDD/SSD) installed in a laptop.

3. Manang Zeny’s Grocery is a merchandiser that provided the following

information:
Amount
Number of units sold 30,000
Selling price per unit P 50
Variable selling expense per unit P6
Variable administrative expense per unit P4
Total fixed selling expense P 60,000
Total fixed administrative expense P 50,000
Beginning merchandise inventory P 34,000
Ending merchandise inventory P 54,000
Merchandise purchases P 200,000

Required:
 Prepare a traditional income statement.
 Prepare a contribution format income statement

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 1 Instructor: Carlo Ian A. Manalansan
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 ILOCOS SUR
POLYTECHNIC STATE
Tagudin Campus
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MODULE 2
4. Samahan ng Magkakalamansi relevant range of production is 18,000 to
22,000 units. When it produces and sells 20,000 units, its average costs per
unit are as follows:

Average Cost per Unit

Direct materials P 8.00
Direct labor P 5.00
Variable manufacturing overhead P 2.50
Fixed manufacturing overhead P 6.00
Fixed selling expense P 4.50
Fixed administrative expense P 3.50
Sales commissions P 2.00
Variable administrative expense P 1.50

Required:
1. Assume the cost object is units of production:
a. What is the total direct manufacturing cost incurred to make 20,000
units?
b. What is the total indirect manufacturing cost incurred to make 20,000
units?
2. Assume the cost object is the Manufacturing Department and that its total
output is 20,000 units.
a. How much total manufacturing cost is directly traceable to the
Manufacturing Department?
b. How much total manufacturing cost is an indirect cost that cannot be
easily traced to the Manufacturing Department?
3. Assume the cost object is the Samahan ng Magkakalamansi’s various
sales representatives. Furthermore, assume that Samahan ng
Magkakalamansi spent P50,000 of its total fixed selling expense on
advertising and the remainder of the total fixed selling expense comprised
the fixed portion of the c Samahan ng Magkakalamansi’s sales
representatives’ compensation.
a. When the Samahan ng Magkakalamansi sells 20,000 units, what is
the total direct selling expense that can be readily traced to
individual sales representatives?
b. When the Samahan ng Magkakalamansi sells 20,000 units, what is
the total indirect selling expense that cannot be readily traced to
individual sales representatives?

Reference(s):
 Garrison, R. H., Noreen, E., & Peter C. Brewer, P. (2019). Managerial accounting.
McGraw-Hill Education.

Course Code: ELECT 103

Descriptive Title: Managerial Accounting 1 Instructor: Carlo Ian A. Manalansan
3
Ilocos Sur Polytechnic State College